Linda K. Frykholm developed a Ponzi scheme promising to pay investors a 100 percent return on their money within a month. She persuaded people to invest $15 million in her get-rich-quick scheme even though she had no means to back up her promises.
A classic Ponzi scheme, the judge explained, involves borrowing money from investors, promising them a high return, and using funds from later investors to pay those high returns.
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As a result, the first investors who receive the high returns recommend the investment to their friends, he noted. Eventually, the Ponzi scheme collapses when more gullible investors can’t be located, the judge added.
“Her only relevant credential was a 1994 conviction for theft and forgery, which she did not tout; her ‘business address’ was a mail drop,” the judge reported.
“When Frykholm’s scam imploded, she had net receipts of about $10 million (having taken in $15 million and paid out $5 million), of which prosecutors have been able to locate some $4 million; the rest either was devoted to living the high life or has been hidden someplace from which Frykholm hopes to retrieve it after her release from 12 years’ imprisonment,” he continued.
Title to all of Frykholm’s assets vests, under the law, in the United States as soon as criminal proceeds are invested, the judge explained, and this forfeiture proceeding just confirms what has occurred.
But one of Frykholm’s investors, Cotswold Trading Co., claims to have priority to assets as a bona fide purchaser for value in her only major asset, the judge noted.
Cotswold entrusted $1.1 million to Frykholm, he added. When she was unable to pay the 100 percent promised return, “Cotswold decided to throw good money after bad. It invested another $1 million in exchange for a promise that Frykholm would deliver $2 million within 13 business days,” the judge revealed.
After she again was unable to pay, Frykholm gave Cotswold a promissory note for $2.2 million due in 100 days secured by a first mortgage on her property at 1982 North Lake Shore Drive in Delavan, Wis., on Lake Geneva, the judge explained. She had purchased this free-and-clear property for $2.28 million with money from other Ponzi scheme fraud victims, he noted.
Cotswold claims to be an innocent bona fide mortgage lender without notice as to this property of Frykholm’s, which is subject to forfeiture, the judge emphasized. If Cotswold prevails as a bona fide purchaser mortgagee and is paid first from the sale of this property, he continued, only about $1.8 million will be left to pay $9 million in fraud victim claims, he explained.
If you were the judge would you rule Cotswold is a bona fide purchaser for value without notice of the fraud and is entitled to full payment from sale of the property?
The judge said no!
Both the government and Cotswold have overlooked a very important fact in this forfeiture case, the judge began. At the time Frykholm gave Cotswold the first mortgage secured by her Lake Geneva property, she owed more than $20 million to her investors but had only $4 million in available assets, he reported.
Because she was insolvent at the time Cotswold received its promissory note secured by the mortgage, under both state and federal law, the mortgage was a fraudulent conveyance, the judge emphasized.
Therefore, Cotswold cannot be a bona fide purchaser entitled to priority as a secured creditor, the judge ruled. Cotswold must stand in line with the other unsecured Ponzi scheme victims, the judge concluded.
Based on the 2004 U.S. Court of Appeals decision in U.S. v. Frykholm, 362 Fed3d 413.
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